Distribution utilities are well positioned to provide tax equity for renewable projects, but some state laws prevent it. Tapping the potential will require progressive leadership by utility...
Green REITs, MLPs, and Up-Cs
enter into two commercial relationships with the same unregulated utility. In the first relationship, the REIT will buy certain REITable assets from the unregulated utility and then lease those assets back to the utility. In the second relationship, the REIT will make a mortgage loan to the unregulated utility secured by any remaining assets owned by the utility. The rent and mortgage interest received by the REIT may be contingent on the unregulated utility’s gross income from the use of the leased assets or the use and sale of the mortgaged assets, respectively.
MLP Operating Models
The MLP capital vehicle is in some ways more flexible than the REIT vehicle but in other ways less. It is more flexible with respect to the landlord model but less flexible with respect to the lender and hybrid landlord-lender models.
In particular, because an MLP isn’t subject to an asset test or the equivalent of the REIT 75 percent gross income test, and MLP can use the landlord model without a limit on the value of personal property ( e.g., machinery and equipment) held indirectly through corporate subsidiaries of an MLP. There is thus no limit on the amount of indirect economic exposure that an MLP may obtain in the personal property components of a facility. This economic exposure, of course, comes at the expense of a corporate-level tax on the corporate subsidiaries of the MLP, but the tax bill can be managed by leverage at those subsidiaries. Figure 6 ( Download a pdf of Figures 1 through 7 here ) illustrates the landlord model in an MLP structure.
On the other hand, because an MLP generally cannot engage in active loan origination, the lender model is not viable for an MLP, and the hybrid landlord-lender model is viable only if the lender portion of the model is strictly limited.
As a result, an unregulated utility that is primarily interested in sale-leaseback financing should give MLPs a close look. An unregulated utility that is primarily interested in borrowing, however, will likely find REITs to be more promising.
As described above and illustrated in Figure 7 ( Download a pdf of Figures 1 through 7 here ), the basic Up-C structure involves a publicly traded C corporation that holds all of its assets indirectly through an entity treated as a partnership for tax purposes. Although it is certainly possible for an Up-C to be a lender, the Up-C vehicle, which was designed to allow a public C corporation to acquire ownership of appreciated assets on a tax-free basis, is most useful for effecting a variation of a sale-leaseback transaction—namely, a tax-free contribution-leaseback. In particular, favorable tax rules govern contributions of appreciated property to a partnership in exchange for interests in that partnership. Such a contribution is generally tax-free, which is often not the case for contributions of property to a publicly traded corporation. A public C corporation can capitalize on the favorable partnership rules by acquiring, on a tax-free basis, appreciated property through a contribution of that property to an operating partnership of